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The puzzle of real median household income

The graph above shows two often-reported series that look at a measure of income adjusted for inflation and population: real median household income and real per capita GDP. They should be similar, but there are quite a few differences. For example, median household income has stagnated for about two decades while per capita GDP has steadily increased. Let’s try to straighten out this puzzle.

The blue line in the middle graph shows that the number of people in each household has decreased. So the number of households in the nation has increased faster than population, which means that any measure divided by population grows faster than one divided by number of households. To see how much this matters quantitatively, we divide both income concepts by the number of households in the bottom graph. Obviously, they still don’t line up, but at least the gap is smaller. What explains the remainder?

First, the income definitions are different: Household income is based on a survey that asks people about only their income, not their employer-provided benefits and retirement contributions. In a previous post, we showed that these benefits have increased relatively more than wages. Real GDP includes all income in the economy. Second, if the distribution of income becomes more unequal, then the median decreases while the mean stays put. How much each of these contribute to the remaining gap can only be determined with a look at the microdata.

How these graphs were create: Top graph: Search for “real median household income,” click on the series, open the “Edit Graph” panel, then select “Index (scale value to 100 for chosen date)” for units, with 1984-01-01 as the date. Then add a line after searching for “real per capita GDP.” Choose the same units. Middle graph: Search for “civilian population,” open the “Edit Graph” panel, then search for “number of households,” and apply the formula a/b. Bottom graph: Repeat the procedure for the top graph for the first line. For the second line, use the “Add Line” feature, search for “real GDP,” then add the “number of households” series, and apply formula a/b. Finally, choose as units “Index (scale value to 100 for chosen date)” with 1984-01-01 in the bottom field, as the units pertain to the result of the formula.

Suggested by Christian Zimmermann.

View on FRED, series used in this post: A939RX0Q048SBEA, CNP16OV, GDPC1, MEHOINUSA672N, TTLHH

Trends and cycles

Are fluctuations in real gross domestic product driven by transitory or persistent factors? Do recessions reflect temporary declines in GDP from trend, or do they have more to do with a shift in the trend itself?

One way to answer these questions is through the lens of the permanent income hypothesis.* The PIH relates to consumer demand: To the extent that households have reasonable access to credit, their desired spending on consumer goods and services should depend primarily on their wealth (permanent income) and not on their current (or transitory) income. Household consumer spending, especially on basics such as food, shelter, and clothing, isn’t likely to change if there’s a temporary change in household income: You’re not likely to move into a smaller apartment because of a lower-than-expected year-end bonus. Yet, as the PIH tells us, consumer spending will change when changes to income are perceived to be permanent or persistent: You may very well have to move to a smaller apartment if you think you’ll be unemployed for a long time.

At the aggregate level, the PIH suggests that consumption expenditures may make for a reasonably good measure of the perceived trend in GDP. So we plot real GDP and real consumption (nondurables plus services) for the U.S. for 1947:Q1-2016:Q2. The graph uses an index for each series so the consumption series passes through the GDP series.

If we interpret consumption as trend, then the data suggest that the nature of the business cycle has changed from the early postwar period (1947:Q1-1984:Q1) to the present (1984:Q2 – 2016:Q2). Early in the sample, both trend and cycle (deviations from trend) play a visibly important role in shaping the time path of GDP. Later in the sample, however, virtually all movement in GDP is accounted for by shifts in trend GDP.

Viewed through this lens, the decline in consumer spending since the Great Recession seems especially worrisome because it suggests that households largely viewed the decline in real income in 2008-09 to be largely permanent.

* See Friedman (1957) for more on the PIH.

How this graph was created: Search for “real gross domestic product per capita” and select the first series in the results. Use the “Units” option near the top of the “Edit Graph” panel to select “Index (Scale value to 100 for chosen period)” and set the date to 1950-01-01. Then, on the “Add line” tab, search for “real consumption per capita nondurables” and add the series to the graph. Add another series to Line 2 by searching for “real consumption per capita services” in the “Customize Data” section and click “Add.” Making sure that each individual series is still in chained 2009 dollars, apply the formula a+b to Line 2. Then, just below where you set the formula, change the units for the new series to an index, using 1947-01-01 as the date, so that the lines lie on top of each other.

Suggested by David Andolfatto and Andrew Spewak.

View on FRED, series used in this post: A796RX0Q048SBEA, A797RX0Q048SBEA, A939RX0Q048SBEA

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